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Why Taking a Pay Cut is a Great Idea

by Kevin Mulligan

This is a guest post by Kevin, who writes a get out of debt blog at No Debt Plan. He wants to help you get and stay out of debt. This is the second post in a series on unemployment and your finances.

In my last article I promised to show you why the income you are losing while being unemployed can likely never be recovered.

Here’s the bottom line: every day you are unemployed increases the likelihood that the job you finally do take will need to pay you more than your previous job.

Let’s run through the math with an example, which will make this very clear.

Calculate Your Weekly Gross Pay

Our example candidate is Joe Unemployed. Mr. Unemployed’s primary skill is providing help desk support to end users. He’s the guy you call when your computer at work isn’t working or you can’t get something to print. Joe normally earns $17 per hour.

If Joe works 40 hours per week he earns $680 before taxes, 401k, insurance, etc.

Joe worked for a large bank that was recently shut down by the FDIC. The bank’s assets were purchased by a competitor that promptly laid off the entire IT division. Joe is now unemployed.

He enjoyed his work and wants to get back to it. But Joe is picky. His last employer had a great 401k and even offered stock options (which, by the way, are now worthless. Let’s hope he didn’t put a large chunk of his savings into company stock!) He worked a flexible schedule so he could come in at 9am and stay until 6pm, or come in at 6am and leave at 3pm. Joe really liked that schedule so he could grab a round of golf with his buddies on Friday afternoon.

Joe loved the perks at his last job and he wants to find another ideal situation. He wants everything that he had at his last job, and maybe more. This causes him to turn down a few potential jobs that he gets calls about the week after he gets laid off.

The Cost of One Week of Unemployment

Let’s say I call Joe on his last day of work. I’ve got an opening with a local client and he could start the following Monday. The job is exactly the same as what he was doing at his last job. The commute is the same, but the hours are strictly 8am to 5pm. The pay is also $16 per hour, one dollar less than he earned at his last job.

Joe declines this job because it pays less and the hours aren’t as nice. It just isn’t the job for him. He is confident he will find a perfect fit in the future. (This is a major mistake and I’ll write more on this in my next article.)

Assume Joe doesn’t find work for the week that he could have been working for me. He has cost himself $640 ($16 per hour x 40 hours). I don’t know about you, but to me that is a lot of money.

Here is the key concept: Joe will need to make at least 31 cents more per hour from the offer I gave him to make up for one week of unemployment. He will need to work an entire year at $16.31 to make up for losing one week’s worth of pay at $16 per hour.

Here’s how the math works:

  • 1 week of unemployment: $16 x 40 = $640
  • The number of work hours in a year = 52 weeks x 40 hours = 2,080
  • $640 for the week divided by the number of work hours in the year, 2080 = $0.307 per hour

And that is just for one week of unemployment.

The Cost of Two Weeks of Unemployment

In a good economy this would still be considered a short time to be sitting on the sidelines. A job may have several rounds of interviews, managers can be delayed in making a decision, and overall the process gets dragged out.

In a poor, recessionary economy two weeks flies by.

Let’s now assume that Joe doesn’t find work for two weeks. He misses out on $1,280 in potential income ($640 per week x 2 weeks).

If he were to find a job starting the following week he would need to make $0.62 more per hour than the $16/hour job I offered him. His total compensation is inching closer to his original $17/hour just to break even on being unemployed.

The Cost of One Month of Unemployment

Things are not looking good for Joe Unemployed. He has been out of work for four weeks straight. He isn’t getting many calls from companies. He is starting to get discouraged.

On top of all that Joe needs to now make at least $1.23 more per hour than the original $16 per hour I offered him. At his last job he was earning $17/hour. Now he needs to make $17.23.

This is the danger most people do not see. In a very short period of time the loss of income from being unemployed outweighs the guaranteed drop in income by taking a lesser paying job.

Because Joe definitely knew he would lose $2,080 over an entire year he avoided jobs that paid less than his old job. But what he doesn’t know that he doesn’t have to be unemployed very long to miss out on that entire amount and more.

Other Unemployment Factors to Consider

Of course this is a simplified example. Some other things that might influence Joe’s decision:

  • He will draw unemployment benefits. I didn’t get into unemployment benefits because every state is different. If Joe could get $200 per week in unemployment then each week he misses work at $16 hour he will need to make 21 cents more (rather than 31 cents more).
  • Was he earning average market pay? If Joe’s skillset typically pays $20 per hour he was being underpaid. It might be worth it to hold out for at least the same pay he was getting, possibly more. But he still needs to be aware of how much each week of sitting at home is costing him in the long run.

Published or updated August 26, 2009.
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{ 9 comments… read them below or add one }

1 gurgle

Thanks for the post. I think it’s basically, more than ever, about weighing up the options and taking the best one for you. It might be that a break is what you want, or it might be that you need the money, even at a lower rate. Consideration is key.

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2 ChristianPF

Kevin,
great article, I remember thinking through this the same way as you described when I knew I was getting laid off. My conclusion was that I had to get work ASAP, even if it didn’t pay as well…

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3 ty

What about the pleasure Joe gets out not working for a time? Maybe he has worked nonstop for 30 years and looks at his job search time as a time to enjoy life, and get paid for it (via unemployment)? Joe could have a sizable bank account, and does not need to “recover” the pay differential. For Joe, it might not be best to take the first job offered to him.

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4 No Debt Plan

That would be something I would place under the Other Unemployment Factors to Consider.

But I would also question — how many people do you know personally that if they lost their job today would be “fine” after several months of unemployment?

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5 Miranda

I think you make some great points here. A lot of people are probably in a similar boat, thinking that they will get what they had before (or something better). In this economy, that’s just not the case. Employers can be way more picky than employees right now.

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6 DDFD at DivorcedDadFrugalDad

Nice analysis of opportunity costs of unemployment and “under-employment”.

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7 Miss T

This is a very good post! Good food for thought but I won’t post all my thoughts here since I’m a girl and tend to ramble… ha ha! I will post a personal blurb though…

Mr. T and I relocated last year when he retired from the military. Mr. T took a very big pay cut, but his military pension did much to fill the gap. It’s still not as much…but…we don’t regret for one second our choice to move for a job that paid less money. Mr. T is home every night and is doing a job that he truly enjoys. When he was encouraged to apply for a supervisory position it was a no-brainer – NO WAY. After 20 years of moving and being stressed to the max in the military, we knew were not going to go back to that life. Our two darling little T’s get to see their daddy every day and every night.

There’s more to life than money – yes, it’s nice to have but it’s not everything.

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8 Jerry Sheehan

I’ll take the unemployment offer and enjoy my life. To me quality of life is much more important than a job that cannot pay well. Taking a pay cut doesn’t make sense and it only adds to the stress and distaste for the job. This affects your health and overall well-being. Great article but it’s not a fit for everyone.

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9 Andrew Lin

I strongly disagree. There is more to life satisfication than money. Having some leisure time between jobs, and job satisfaction are definitely two other things important in life. Having said that, do respond respectfully to any offers you get and follow up.

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